each monthly payment will be higher. (Remember: the shorter the loan term, the greater the amount paid in each installment). For example, going from a 30-year, $100,000 mortgage at an 8.5% interest rate to a 15-year loan at 8% might raise your monthly payment from about $730 to $930. However, you’ll avoid 15 years of interest payments and get a slight break on rates, saving you around $90,000 in total outlays. However, 15-year loans are best for people who have solid job security as well as enough income to cover the monthly payments.
“Most people like the comfort of not having a mortgage,” says Baldwin. “If you can afford the monthly payments, take a 15-year loan to get your mortgage paid down rapidly. Try to negotiate a loan with no points and low closing costs, and be ready to refinance when rates drop.”
Daniel Boyce, a certified financial planner in Southfield, Michigan, offers another suggestion. “I often recommend a 30-year mortgage,” he says, “and tell clients that they can pay it off at the same rate as a 15-year mortgage. That way, they can cut back to the 30-year payment [schedule] if they have cash flow problems and not jeopardize their credit rating or their ownership of the home.” One caveat: make sure your lender allows prepayments. Some don’t, or sock you with a penalty.
Adjustable-rate mortgages (ARMs). These mortgages have a low initial rate but adjust each year to reflect the current mortgage environment. Generally, the introductory rates are the lowest available: the national average recently was under 7%. The low initial rate means a lower monthly payment, and may enable you to qualify for a larger loan in relation to your income. But because the loan rate goes up when interest rates do, ARMs work best for people who don’t plan to stay in a house for long or who expect their income to increase substantially in the future.
This basic one-year ARM was a good fit for Brown-Postell, who was willing to assume the risk of higher future rates because her job was secure and her income from freelance assignments likely to increase. Also, “She got a 6.5% loan,” says Virginia Siler, the loan officer at Wells Fargo in Dayton, who helped Brown-Postell through the process. “This loan is called a ‘1 and 5 loan,’ meaning that the interest rate can go up no more than 1% per year and 5% over the life of the loan, for a cap of 11.5%. We used a 7.5% rate-assuming a 1% increase after one year-to compare the projected payment with her monthly income and qualify her for the loan.”
The loan is structured so that Brown-Postell can refinance it easily if interest rates fall in the future, according to Siler. “No credit check will be necessary; all that will need to be done is to reconfirm the value of the house. Even if rates don’t fall, she should be all right because [Brown-Postell] can expect her income to increase during her professional career,”